Tick sizes in financial markets and their effect on trading

30 11 2016 - Pas de Commentaire, soyez le premier

Tick size is an anti-scalping weapon for brokers and a handicap imposed on traders

 Definition of tick size

A tick size is the minimum gap between 2 consecutive prices. It is the gap between the bid and offer price, imposed by regulators of regulated products, such as futures or CFD brokers who choose their tick size freely.

It is not possible to override the tick size and it is often more important for a trader that the spread or the commission fees, but it is often forgotten in the equation. Effectively, tick size has direct implications on trading methods, price stability and at the end of the day, the trader’s earnings. For scalping, it is really a fundamental element of the scalper's success or failure. I am always surprised at how few articles are devoted to this subject. It is certainly not considered politically correct to talk about it, because tick size is one of the main sources of CFD brokers’ income. It is a very low key but extremely effective source of income. The tick size, is the additional handicap that some brokers impose on their customers to earn money.

Examples of tick sizes in financial markets

Each futures contract has its own tick size. For example, the S&P 500 mini futures have a tick size of 0.25 (ES Futures), the DAX 30 futures have a tick size of 0.5, and Dow Jones 30 (YM futures) have a tick size of 1 point.

In real terms, in this is what prices could look like in the futures order book (as long as the ask and the bid price are touching, which is not always the case):
S&P 500: Buy 2177 Sell 2176.75
Dax 30: Buy 10711 Sell 10711.5: tick size 0.5
Dow Jones 30: Buy 16678 Sell 16679: tick size 1
So if you buy Dow Jones 30 futures at 16678, your only opportunity to make a profit is to sell at 16679 (as long as your commission fees are under 1 point). It is absolutely impossible to exit at 16678.5 or 16678.4. The tick size is enforced. It is the same for all futures, there is no difference. But for CFDs, each broker can choose his tick size and there are numerous disparities. Some brokers give a tick size of 0.1 to 0.5 and other brokers give 1, or 1.5 to 2.

The impact of tick size on trading

Tick size is an excellent way for the CFD brokers to make money, at our expense, unobtrusively. Also, I am always surprised to see it when CFD brokers offer a tick size of 1 on the Dax 30 indices but their CFDs are supposed to be based on the price of futures which have a tick size of 0.5.

As you can see CFD prices do not therefore perfectly replicate futures prices when a CFD broker uses a 1 point tick size. When a futures contract on the Dax 30 is quoted at 10711, 10711.5, the CFD broker with a tick of 1 will show his clients: 10711, 10712 and, there it is! 0.5 in his pocket, with that much less for us. I find therefore that as CFDs are supposed to be based on futures, CFD brokers should be obliged to comply with tick sizes of the underlying financial instruments. Some CFD brokers play the game and offer a tick size of 0.5 or even 0.1 on the CFDs indices, we can therefore enter or exit at 4350.1, 4350.2, 4350.3, 4350.4 etc.

This difference in tick size between 0.1 and 1 is absolutely fundamental for a scalper, for his survival. In fact, a scalper will try to garner a few quick points in a few seconds. A broker who rates his index with a tick size of 0.1 will thus automatically give a lot more ticks, options to enter or exit (with a total of between 1 and 10 times more). If you compare the live data, it is absolutely obvious, you get the impression of watching one stream of quick quotations and one stream of slow quotations. In this way it is possible for you to exit flat or with a gain much more often with as small a tick size as possible. Fluidity, and that is what scalpers look for as a priority, a fluid index AND fluid quotations (to be able to enter and exit positions unhindered). For traders holding onto their indicators and automatic trading, the figures will be different with a tick size of 0.1 or 1, the first will provide a lot more ticks (up to a maximum of 10 times more), and more accurate extremes than the second. Thus, in theory more reliable backtesting because it is based on more data.

Tick size or hidden costs

The higher the tick size, the more the broker (or the regulator depending on the market) handicaps the scalper from making a profit. This is even beyond price fluidity which is indispensable.

Let us take the case of the DAX 30 with an identical spread of 1, which is the current standard among CFD brokers.

You buy and the price with CFD brokers is:

sell 10000 buy 10001 (you therefore have a spread of 1 to pay, which is the equivalent of round-turn commissions for those who do not know CFDs well)

To make money, with brokers using a tick size of 0.1, you must wait until the price increases to 10001.1, exiting with a gain of 0.1 or a real spread of 1.1. At 10002, you gain 1 point net.

To make money, with brokers using a tick size of 1, you must wait until the price increases to 10002 to make a profit, exiting with a gain of 1 or a real spread of 2.

You can see here the handicap that the CFD broker artificially imposes by using a 1 point tick size. To make a profit, you need a 2 point gap rather than 1.1, the difficulty is 0.9 of a point more, or +55%.

You can make as much of course, as the starting spread is the same, but the difficulty is the +55% on each point earned. You can never exit at +9.5 you will need to take +9 or risk waiting to aim for +10. And if you are unlucky, while you are waiting the price can lower and will be at +8 and not +8.1, +8.2, + 8.3, +8.9, etc. By and large, the higher the tick size, the greater our handicap to make the same amount. And in the long term, the broker is the winner.


sclaping tick size

Tick size, the anti-scalping weapon

Scalping and tick size

For people who do not scalp, this may appear insignificant, but this radically changes everything for micro scalpers like me. I often exit with a profit of €2.5 to €22.5 with a 0.1 to 0.9 gap on the DAX 30 (I love scalping at +€12.5 at +0.5, very effective in a flat area). If the CFD broker has a tick size of 1 this is impossible, I have to wait until the price shifts by 1 and risk seeing the price turn against me. This delay works in favour of CFD brokers. I have previously discussed this with someone who is one of the top 5 managers of a large French broker. I asked him why they gave a tick size of 1. The response was very clear: "We do not want scalpers using us, this trading profile doesn’t interest us". (Do scalpers pinch brokers’ money more easily than day traders? As he appeared annoyed, I didn’t push the point). Tick size is therefore a deterrent to dissuade experienced scalpers.

To calculate your real spread to make a profit, you need to take the tick size into account.

The real spread that you pay to make money: spread + tick size

I’ll give you one last example:

In May I made €3,582.64 net on 124 trades concluded on the DAX 30 at €25 per point.

If I'd had 0.9 more tick size, the maximum additional costs would have been €2,790 in fees paid to the broker with a 1 point tick size. That is the least to make the maximum (124x25x0.9).  On average I make €26.47 per trade or barely 1 point. That is the average, more than 50% of my trades are lower than a 1 point gain or they are flat. This is impossible if the broker has a 1 point tick size, some of these trades would be losers. Scalping would no longer be viable for me. I have tried trading for 72 hours with a broker who used a 1 point tick size, I struggled to finish flat. I had the impression of trading the same, but it was much more difficult. And yes, the difficulty was the +55% to exit a trade as a winner... after this experience I became fully aware. I now understand the disbelief of some traders because with a spread of 2 at their broker (yes that still exists) and a tick size of 1, they must make +3 to make money. To make money at + 1.1 seems impossible to them and that is technically true, with their broker, it is impossible.

Of course, if you do swing trading or day trading, the tick size has almost no impact, but for scalping, it is a question of survival.

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